Knowing how to convert an annual percentage rate to a monthly rate allows your business to calculate the interest charges on a loan subject to monthly compounding. With this metric, you can assess costs of a loan month to month, while an effective interest rate calculator lets you review the cost on an annual basis. When you need to borrow money to expand your small business or invest funds, these calculations help you locate the best option.

Financial Formulas Components

Most financial calculations and formulas rely on a few basic pieces of information, including the interest rate and number of payment periods. Formulas for calculating the monthly interest rate and effective annual rate rely on the stated interest rate, which is expressed by the variable "i." If you are unsure of your annual interest rate, look at your most recent statement or the original loan. The number of pay periods is expressed by the variable "n." For a monthly interest rate calculation, "n" represents the number of months in a year, or 12.

In other formulas, it can represent the number of payment periods in the life of the loan, such as 120 payments in a 10-year loan. If you are calculating your monthly rate from an APR, always use 12 periods – even if your loan is for a smaller time frame, such as six months, or a longer period, like three years.

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Converting APR to Monthly

To convert an annual interest rate to monthly, use the formula "i" divided by "n," or interest divided by payment periods. For example, to determine the monthly rate on a $1,200 loan with one year of payments and a 10 percent APR, divide by 12, or 10 ÷ 12, to arrive at 0.0083 percent as the monthly rate. On a $1,200 balance, the first month's interest would be determined by multiplying the monthly rate by the total, or $1,200 x 0.0083, to arrive at $9.96.

Amortization Schedules and Interest

This simple calculation provides a look at basic interest calculations, but many loans contain more complicated amortization schedules. With these payment plans, loans have a flat monthly payment. Throughout the life of the loan, more of your interest charges are paid at the beginning of the loan period. As the loan ages, the mix flips to larger principal payments. If your goal is to limit interest payments on your loans, make additional payments whenever possible and ask your bank to apply the extra payment to the principal. You will also need to refer to your amortization schedule to properly attribute monthly expenses in your financial reports.

Effective Annual Rates

When your interest on a loan is calculated monthly, it compounds, and you end up paying interest on previously assessed interest. Because of this, the stated APR you pay on a loan is actually less than the overall effect of the interest on your bottom line. If you are calculating your monthly interest rate in an effort to assess loan options, reviewing the effective rate is also valuable.

The effective annual rate formula is [1 + (i/n)] ^n -1. To complete the formula, you divide the stated annual interest rate by the number of periods, add 1, and then multiply the answer by the power of n, or the number of periods. Subtract 1 from that answer.

Example:

A 10 percent interest loan with 12 periods would be solved as follows:

0.10/12 = 0.0083

1+ 0.0083 = 1.0083

1.0083^12 = 1.1043

1.1043-1 = 0.1043, or a 10.43 percent effective annual rate.

To multiply an item to the power of another number is to multiply it by itself the stated number of times. In this example, 1.0083 is multiplied by itself 12 times to arrive at 1.1043. If you have access to a scientific calculator, you can use the exponent button to simplify this calculation.

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About the Author

Ashley Adams-Mott has 12 years of small business management experience and has covered personal finance, career and small business topics since 2009. She is a full-time government and public safety reporter and holds a BSBA in accounting from Columbia College. Her work has appeared online with USA Today, The Nest, The Motley Fool, and Yahoo! Finance.